- The Five Factors That Affect Your Credit Score
- Why Your Credit Score Might Drop
If you’re trying to keep your credit score high, you might be wondering why it sometimes goes down. Here are a few reasons why your credit score might dip.
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The Five Factors That Affect Your Credit Score
Your credit score is a numerical representation of your creditworthiness. Lenders use your credit score to determine whether or not you are a good candidate for a loan. A low credit score may result in you being denied for a loan, or you may be offered a loan with a high interest rate. There are five factors that affect your credit score.
On-time payments are the single biggest factor in your credit score—accounting for about 35% of your FICO® Score sim grade—so staying current is critical to maintaining a good credit score.
If you have a history of late or missing payments, it will hurt your credit score and make it harder to get approved for new credit products. To stay on top of your payments, sign up for automatic payments or alerts from your bank or credit card issuer. You can also check your credit report regularly to track your progress.
Credit utilization is one of the most important factors in your credit score. It refers to how much of your available credit you are using at any given time. For example, if you have a credit card with a $1,000 limit and you spend $500 in one month, your credit utilization would be 50%.
Ideally, you want to keep your credit utilization below 30% to maintain a good credit score. However, if you’re trying to improve your credit score, you should aim for a utilization rate of 10% or less.
Length of Credit History
One of the five things that affect your credit score is the length of your credit history. This is determined by taking a look at the oldest account on your credit report and calculating how long it’s been since that account was opened. A longer credit history will generally result in a higher score, because it shows that you’ve had more time to build a good payment history.
If you have a shorter credit history, there are still things you can do to improve your score. One is to make sure you make all your payments on time. Another is to keep your balances low, which shows lenders that you’re using credit responsibly.
Types of Credit
There are five main types of credit: revolving, installment, open-ended, mortgage, and secured. Each has its own effect on your credit score.
Revolving Credit: This is a type of credit that allows you to borrow money up to a certain limit and then pay it back over time. The most common form of revolving credit is a credit card. When you use a credit card, you are essentially borrowing money from the card issuer and then paying it back (with interest) over time. Your payment history and the amount of debt you carry on your revolving accounts will affect your credit score.
Installment Credit: This is a type of credit that requires you to make fixed payments over a period of time. The most common form of installment credit is a car loan or a student loan. Your payment history on installment accounts will affect your credit score.
Open-Ended Credit: This is a type of credit that allows you to borrow money up to a certain limit and then pay it back over time. Open-ended credits typically have lower interest rates than revolving credits because they are considered to be less risky. The most common form of open-ended credit is a home equity line of credit (HELOC). Your payment history on open-ended accounts will affect your credit score.
Mortgage: A mortgage is a type of installment loan that is used to finance the purchase of a home. Your payment history on your mortgage will affect your credit score.
Secured Credit: Secured credits are those that are backed by collateral, such as a car or home. If you default on a secured loan, the lender can seize the collateral to recoup their losses. Your payment history on secured credits will affect your credit score
Opening too many credit accounts in a short period of time represents greater credit risk. Credit scoring systems will give you a few points for each account you have had open for more than a year, and a few more points for each account that has been kept in good standing. But opening several new accounts at once appears to be an indication that you may be taking on too much new debt, so your score will suffer as a result.
Why Your Credit Score Might Drop
Your credit score is a number that lenders use to determine your creditworthiness. A good credit score means you’re more likely to get approved for a loan or credit card and get a lower interest rate. A bad credit score can make it harder to get approved for credit and can lead to higher interest rates. So, what causes your credit score to go down?
You Missed a Payment
If you’ve missed a payment on any type of debt, your credit score will take a hit. The amount of the drop will depend on how late the payment was, how much you owed, and your credit history. If you have a history of making late payments, your score will drop more than if this is a one-time thing.
You Used More Than 30% of Your Available Credit
If you carry credit card debt from month to month, you’re certainly not alone. According to the latest figures from the Pew Charitable Trusts, about 69% of Americans carry some sort of debt other than a mortgage, and 36% carry credit card debt specifically.
If you’re one of those people who carries a balance on your cards, you might have noticed that it can have an impact on your credit score. In fact, one of the biggest factors in your score is your “credit utilization ratio.” This is the amount of credit you’re using compared to the amount of credit available to you, and it’s expressed as a percentage.
For example, let’s say you have two credit cards with limits of $5,000 each. One has a balance of $1,000 and the other has a balance of $500. Your combined credit utilization ratio would be 30%, which is calculated by adding up the balances ($1,500) and dividing by the total credit limit ($10,000).
Many experts recommend keeping your credit utilization ratio below 30%, but if yours is higher, don’t panic. There are a few things you can do to bring it down and improve your score.
You Opened a New Credit Card
Opening a new credit card will result in a hard inquiry on your credit report, which can temporarily lower your credit score by a few points. Additionally, having a new account will decrease the average age of your accounts, which can also have a negative impact on your score.
This temporary dip in your score is nothing to worry about as long as you manage your new credit card responsibly. After a few months, your credit score will likely rebound and may even be higher than it was before you opened the new account.
You Closed an Older Credit Card
Closing a credit card hurts your credit score in several ways.
First, it lowers your credit utilization ratio, which is the second most important factor in your credit score. Your credit utilization ratio is the percentage of your available credit that you’re using at any given time. So, if you have a $1,000 limit on a credit card and you owe $500, your credit utilization ratio is 50%.
Ideally, you want to keep your credit utilization ratio below 30%. So, if you close a credit card with a $1,000 limit and you have other cards with Limits of $3,000 and $5,000, your credit utilization ratio just jumped from 33% to 40%.
Second, closing an older credit card will shorten the length of your credit history. A longer credit history is better for your score because it shows lenders that you’re a responsible borrower who has managed different types of debt over time.
Third, closing a card will eliminate any positive payment history you have with that lender. When you make on-time payments each month, it reflects well on your financial responsibility and can help improve your score over time.
You Appeared in a Credit Report as Having Filed for Bankruptcy
One of the reasons your credit score may have taken a hit is you appeared in a credit report as having filed for bankruptcy. When you file for bankruptcy, it’s noted on your credit report for up to 10 years, and can be a red flag for future lenders.